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RSI As An Exit Tool

Over the past 12 years of futures trading, I have taken a singular approach to the use of the relative strength index (see sidebar, "RSI"). I have discovered that RSI is unreliable for market entry. For exiting the market, however, the index can be very impressive. For traders who take multiple contracts in a futures market, using RSI can be even more dynamic.

It is a common practice for traders to use a trailing stop order to protect profits on positions that are working in their favor. Many traders will use a simple moving average to locate the area in which to place a stop-loss order, then place their order under the average and move the stop as the moving average increases or decreases. That's the technique I use along with RSI to exit positions.

Figure 1 is a chart of the Treasury bond market in a sideways pattern. I only use multiple contracts in the futures market, which allows me to be flexible enough to reduce my potential loss while still being able to participate in the potential profit of the transaction.

Whenever the nine-day RSI rises into the 75 area, I liquidate 10% of my position, or at least one contract. If the RSI rises into the 80 area I will liquidate 50% of my remaining position, and if the RSI rises into the 90 area, I will liquidate 90% of my remaining position. These RSI levels have a history of indicating exhaustion of the buying for the price run. Obviously, the stronger the underlying fundamentals are, the higher the RSI could get, but even in strong bull markets, runs will tend to play out in regions above the 75 level.

For the remainder of my position I will use a trailing stop. At RSI values of 75, I place the stop just under the nine-day moving average; at the RSI 80 level I move the stop to just under the four-day moving average, and at the RSI 90 level I raise the stop to just below the previous day's low.

Conversely, if I am short in a sideways market, I will look for the RSI to decline into the 25 level, at which point I will liquidate 10% of my position or at least one contract. I will close out 50% of the remaining position at the RSI 20 level and 90% at the RSI 15 level.

Planning a strategy for market entry is only half the battle; you must also plan for protection and for market exit.

FIGURE 1: On the daily bar chart are plotted the numerical values from the RSI chart. Liquidate 10% of your position when RSI hits 75, 50% of the remaining at an RSI value of 80.

FIGURE 2: During bull markets, positions should not be partially liquidated until the RSI reaches 80.

FIGURE 3: Partial liquidation of profitable short positions is warranted when the RSI hits 25.